1. STARTUP ESSENTIALS: Part 2 of 4 Financing Your Startup
Adam Yormack | Partner
Escalante Yormack Law, PLLC

2. Topics Part 2: Startup Financing Part 1: Startup Formation Part 3:
Overview
Typical characteristics
Types of investors
Types of instruments
Seed financing mistakes
Part 3:
Advanced Level Financing
Beyond the Seed rounds VC
Institutional Investors
Part 1:
Startup Formation
Choosing an entity
Founder issues
IP issues
Operating Agreement/Shareholder Agreement
Membership distribution
Partnership
Membership Incentive Agreements
Other formation issues
Formation mistakes

3. Seed Financing Overview
Seed Stage of Development
The first stage of venture capital financing. Seed Stage financings are often comparatively modest amounts of capital provided to inventors or entrepreneurs to finance the early development of a new product or service.
Development
Market Research
Building a management team
A genuine seed-stage company has usually not yet established commercial operations - a cash infusion is essential.
Seed-stage VC funds will typically participate in later investment rounds with other equity players to finance business expansion costs such as sales and distribution, parts and inventory, hiring, training and marketing. 

4. Seed Financing Overview
Typical Amounts Raised
An initial seed investment round made by a professional VC firm typically ranges from $250,000 to $1 million. 
Angels are anywhere from a few thousand to $250,000.
Types of Investors
Friends, Family and Fools
Angels, Super-angels
Seed-stage VC funds

5. Seed Financing: Following the Rules Reg 506(b)
Number of Investors Restriction
506 (b) Rules
Unlimited Accredited Investors and Unlimited Amount
35 other purchases. All non-accredited investors, must be “sophisticated” – they must have sufficient knowledge and experience in financial and business matters to make them capable of evaluation the merits and risks.
Companies have to make the determination, what needs to be provided to the investors, “do no harm”, no false or misleading statements.
Companies must give non-accredited investors disclosure documents, similar to Reg A – financial statements, potentially audited.

6. Seed Financing: Following the Rules Reg 506(c)
506 (c) Rules
Broad solicitation and generally advertise.
Investors all have to be accredited investors.
The company takes reasonable steps (questionnaire) to verify that the investors are accredited investors, which include reviewing documentation, such as W-2’s, tax returns, bank and brokerage statements, credit reports and the like.
PPM (Business Plan), Subscription Agreement, Operating Agreement, Investor Questionnaire,

7. Other Great Funding Tools, Convertible Note
Convertible Notes
The convertible note is a form of short-term debt that converts to equity, typically in conjunction with a financing round.
The investor is loaning money to the startup and instead of a return in the form of principle plus interest, the investor would receive equity in the company
Debt that converts to equity, at a discount, but still gets the investor “in the deal”.
Stock provided at a discount, less per share. Yeah!
Pros – Allows for a round of capital w/o giving away a % of the company.
Con – Convertible notes can effect the decision making of the next round of capital. New investors may not like the terms, ect.
Angels are actually preferring to invest more simply.

8. Other Great Funding Tools, SAFE
A SAFE is a (simple agreement for future equity).
Simpler alternatives to convertible notes, created in 2013 by Y combinator.
Allows startups to structure seed investments without interest rates or maturity dates.
Not debt and do not accrue interest.

9. Biggest Financing Mistakes
Excessively low valuation cap in notes or SAFEs
Excessively high pre-money valuation in Series Seed preferred stock financing
Overly aggressive preferred stock terms
Participating preferred
Multiple liquidation preference
Cumulative dividends Giving seed investors too much control over the company’s operations or future financings/exits

10. Types of Financing

11. Crowdfunding? What’s that?
Involves the use of the internet and social media to raise capital, typically from a large number of individuals, in relatively small amounts.
By using the internet and social media with limitless reach, crowdfunding also raises complex federal, state and even non-US securities liability questions.
Enables small and early staged businesses that may not have easy access to traditional methods of capital formation and fundraising.
Raising capital for a business from investors with a financial interest in business' success brings crowdfunding under the jurisdiction of federal and state securities laws.
Such a type of crowdfunding is illegal without registering the offering with the SEC or fitting within an exemption from registration.
Traditional registration exemptions are often unavailable or difficult to take advantage of in the crowdfunding context.

12. Rewards Funding Simplified
Examples: Kickstarter & Indiegogo
Inventors, artists and entrepreneurs seek funds to finance their projects, products or businesses
Typically used to finance consumer products and artistic projects
Generally no restrictions on who can participate
Contributors DO NOT get equity interests, but may receive
Small gifts or rewards (such as branded T-shirts, tickets, etc.)
Initial products (pre-payment model)

13. Accredited Investor Simplified
Examples: AngelList, CircleUp, & SeedInvest
Startups raise seed capital from large groups of angels Outgrowth of formal angel investing networks
Only open to “accredited investors” (AIs) Net worth > $1MM (excluding value of primary residence) OR
Annual income > $200K for last 2 years + reasonable expectation of earning at least that much this year
Investors receive equity in the companies

14. Federal Funding Simplified
Federal equity crowdfunding for non-accredited investors
Congress created framework in Title III of the Jumpstart Our Business Startups (JOBS) Act enacted in 2012
SEC proposed rules to implement Title III in Oct. 2013
Final SEC rules (called Regulation Crowdfunding) adopted in Oct became effective on May 16, 2016
SEC has approved 9 “funding portals” so far

15. “Blue Sky” Crowdfunding
After Congress passed the JOBS Act, many states did not wait for SEC rulemaking process
States created their own crowdfunding regulatory regimes for intrastate offerings exempt from federal registration
Over half the U.S. states have adopted some form of “blue sky” crowdfunding regulation
The JOBS Act also provides that a state may only enforce state laws, rules or regulations against a registered funding portal with respect to its business as a funding portal if:
The portal's principal place of business is in that state.
The state's laws, rules and regulations are not in addition to or different from the requirements for registered funding portals established by the SEC.

16. Public Offering (Starting Small)
Examples: StartEngine & SeedInvest
Early Stage/Startup companies use a “mini” public offering framework under amended Regulation A (or Reg. “A+”) to sell equity to the general public
Old Regulation A was seldomly used because of $5 million limit and lack of “blue sky” preemption
Congress ordered SEC to overhaul old Regulation A in Title IV of the JOBS Act

17. Peer to Peer Lending (“P2P”)
Examples: Lending Club & Prosper Marketplace
Not advertised as “crowdfunding” but very similar:
Online borrowing platforms
Large number of lenders
Each lender individually commits relatively small amounts to the principal of each borrower’s loan
Not limited to accredited investors
Investors receive debt, not equity

18. Adam Yormack Partner Escalante Yormack Law, PLLC 5201 Blue Lagoon Dr
Adam Yormack Partner Escalante Yormack Law, PLLC Blue Lagoon Dr., 200 | Miami, FL | | eylawyers.com